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THE LAW OF DEMAND WITH ASSUMPTIONS AND EXCEPTIONS

Law of Demand : Introduction : The law of demand was introduced by Prof. Alfred Marshall in his book, ‘Principles of Economics’, which was published in 1890. The law explains the functional relationship between price and quantity demanded. Statement of the Law : According to Prof. Alfred Marshall, “Other things being equal, higher the price of a commodity, smaller is the quantity demanded and lower the price of a commodity, larger is the quantity demanded.” In other words, other factors remaining constant, if the price of a commodity rises, demand for it falls and when price of a commodity falls demand for the commodity rises. Thus, there is an inverse relationship between price and quantity demanded. Symbolically, the functional relationship between demand and price is expressed as : Dx = f (Px) Where D = Demand for a commodity x = Commodity f = Function Px = Price of a commodity Assumptions : Law of demand is based on the following assumptions : 1) Constant level of income : If the law of demand is to find true operate then, consumers' income should remain constant. If there is a rise in income, people may demand more at a given price. 2) No change in size of population : It is assumed that the size of population remains unchanged. Any change in the size and composition of population of a country affects the total demand for the product. 3) Prices of substitute goods remain constant : It is assumed that the prices of substitutes remain unchanged. Any change in the price of the substitute will affect the demand for the commodity. 4) Prices of complementary goods remain constant : It is assumed that the prices of complementary goods remain unchanged because a change in the price of one good will affect the demand for the other. 5) No expectations about future changes in prices : It is assumed that consumers do not expect any further change in price in the near future. If consumers expect a rise in prices in future, they may demand more in the present even at existing high price. 6) No change in tastes, habits, preferences, fashions etc. : It is assumed that consumers' tastes, habits, preferences, fashions etc. should remain unchanged. Any change in these factors will lead to a change in demand. 7) No change in taxation policy : Taxation policy of the government has a great impact on demand for various goods and services. Therefore, it is assumed that there is no change in the policy of taxation declared by Government. The law of demand is explained with the help of the following demand schedule and diagram. Demand schedule : Table. 3.3 Price of commodity ‘x’ (`) Quantity demanded of commodity ‘x’ (in kgs.) 50 1 40 2 30 3 20 4 10 5 As shown in Table 3.3 when price of commodity ‘x’ is ` 50, quantity demanded is 1 kg. When price falls from ` 50 to ` 40, quantity demanded rises from 1 kg to 2 kgs. Similarly, at price ` 30, quantity demanded is 3 kgs and when price falls from ` 20 to ` 10, quantity demanded rises from 4 kg sto 5 kgs Thus, as the price of a commodity falls, quantity demanded rises and when price of commodity rises, quantity demanded falls. This shows an inverse relationship between price and quantity demanded. Exceptions to the Law of Demand : There are certain exceptions to the law of demand. It means that under exceptional circumstances, consumer buys more when the price of commodity rises and buys less when price of commodity falls. In such cases, demand curve slopes upwards from left to right. Following are the exceptions to the law of demand: 1) Giffen's paradox : Inferior goods or low quality goods are those goods whose demand does not rise even if their price falls. At times, demand decreases when the price of such commodities fall. 2) Prestige goods : Expensive goods like diamond, gold etc. are status symbol. So rich people buy more of it, even when their prices are high. 3) Speculation : The law of demand does not hold true when people expect prices to rise still further. In this case, although the prices have risen today, consumers will demand more in anticipation of further rise in price. For example, prices of oil, sugar etc. tend to rise before Diwali. So people go on purchasing more at a high price as they anticipate that prices may rise during Diwali. 4) Price illusion : Consumers have an illusion that high priced goods are of a better quality. Therefore, the demand for such goods tend to increase with a rise in their prices. 5) Ignorance : Sometimes, due to ignorance people buy more of a commodity at high price. This may happen when consumer is ignorant about the price of that commodity at other places. 6) Habitual goods : Due to habit of consumption, certain goods like tea is purchased in required quantities even at a higher price.